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Stock Dividend Yield Pros and Cons Explained for Beginners

The stock dividend yield is a good option to start growing your portfolio. With dividends paid annually, investors can choose from a range of issuing companies ready to pay the percentage of the current asset price to the shareholders. Although some consider it a safe and long-lasting investment opportunity, the dividend yield can have specific downsides traders must be aware of.

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In this article, you will learn how to calculate dividend yield as well as the advantages and disadvantages of adding yielding stocks to your portfolio.

Understanding the Dividend Yield

A dividend yield is the percentage of the current stock price paid to shareholders on the annual basis. Investors have a chance to know exactly how much income they can expect for the price they pay today, considering the dividends will stay the same throughout the entire investment period.

However, the main downside here is that the dividend yield can change. It can be caused by the company’s decision to increase or decrease the percentage. Other reasons may involve market fluctuation. In other words, the dividend change does not always refer to the market moves. On the other hand, it can still be a helpful metric to identify the valuation of a stock trade and find the asset that meets your income preferences.

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How to Calculate Dividend Yield?

The dividend yield formula will depend on the dividends’ payout structure. Some companies prefer paying shareholders on a monthly basis. Others use quarterly, semiannual or annual models. To calculate the yield, you need to multiply your income from a single payment by the number of annual payments (4 for quarterly, 12 for monthly, and so on).

Speaking about the best payment schedule, some investors prefer more rapid payouts and opt for monthly dividends. However, not all companies do that. You need to choose the one that refers to real estate or the REIT category. Thanks to specific tax advantages, these types of businesses have a chance to provide shareholders with above-average dividends.

Factors to Consider when Choosing Stock Dividend Yield

Just like with every stock dividend, investors need to clearly understand that a high dividend yield does not necessarily mean a good investment opportunity. Although there are a few stumbling blocks that may occur with well-performing companies, you still need to be aware of the following:

  • Dividend growth – the ability to increase earnings in the long run.
  • Financial strength – the availability of sufficient working capital and cash as the means to override crises or other unexpected changes.
  • Competitive advantages – how the company differs from the main competitors and what benefits it can deliver to the end-user.
  • Dividend stability – measured by the payout ratio (how much profit a company can spend on dividends).

Dividend traps – high dividend yields can sometimes be associated with the company’s troubles. In some industries, businesses pay higher yields because of lower growth and development prospects. Besides, if the underlying yield is far higher than the one offered by the closest competitors, there is definitely something wrong with the company.

Dividend Yield Pros and Cons

On the one hand, stock dividend yield can be a great way to diversify your portfolio. However, you should not rely mainly on it. Here are crucial pros and cons to consider.

Pros: First of all, a dividend yield can be used as a metric to understand how the company is doing and if it is worth investing in. Using a simple formula, it is possible to figure out of the company is able to keep on paying its shareholders. Additionally, it can be a good solution as a starting point for beginner investors. Last but not least, it helps to evaluate the asset when using historical levels and the company’s performance tracking.

Cons: Unfortunately, many beginners make a common mistake when relying only on the yield of misusing it. Some investors fail to choose a company properly, as they do not take into account the factors we have described earlier. Ignoring them can be a huge mistake.

Additionally, dividend yield traps are becoming more common today. So, whatever you invest in, never spend all your capital and take necessary precautions to consider potential risks.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.